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Tracing the Global Minimum Tax Rule’s Path for Success

David D. Stewart: Welcome to the podcast. I'm David Stewart, editor in chief of Tax Notes Today International. This week: minimum effort. As the OECD inclusive framework strives to finalize its two-pillar global tax reform agreement, discussions around pillar 2 are now focused on what the rate of the global minimum tax should be. One widely discussed number is 15 percent, but some are calling for a higher rate, while 15 percent is perceived by others as too high already. There also remain concerns about how the global minimum tax will be implemented, especially as the OECD considers carveouts and exemptions. So, why is the global minimum tax so important? And how will implementing this tax affect the countries' tax regimes? Here to talk more about this is Tax Notes contributing editor Nana Ama Sarfo. Ama, welcome back to the podcast.

Nana Ama Sarfo: Thanks Dave. It's good to be back.

David D. Stewart: When we last discussed the two-pillar agreement with Tax Notes chief correspondent Stephanie Soong Johnston, which we'll link to in the show notes, 132 out of 139 countries in the inclusive framework had signed onto the agreement. So, Ama, have there been any updates?

Nana Ama Sarfo: Yes, there actually have. So, more countries have signed onto both the agreement and the inclusive framework. Togo is the newest member to join both. So, now there are 140 countries in the inclusive framework, and 134 countries have agreed to the deal. So, as of today, the six holdouts remaining are Estonia, Hungary, Ireland, Kenya, Nigeria, and Sri Lanka.

David D. Stewart: Now, I understand you recently spoke with someone about the global minimum tax. Could you tell us about your guest and what you talked about?

Nana Ama Sarfo: Yes. I spoke with Mark Strimber, who is a principal at RSM US in the firm's international tax practice. And he's also an adjunct professor at Baruch College in New York City. And Mark explained some of the history and background on a global minimum tax. Mainly, how did we even get to a place where a proposal like this is viable? And he explained the mechanics of the proposal and also delved into some of the design issues, especially involving carveouts and exemptions.

David D. Stewart: All right. Let's go to that interview.

Nana Ama Sarfo: Hi Mark. It's great to have you on the podcast.

Mark Strimber: Hi Nana. Thank you for having me today.

Nana Ama Sarfo: So, in October, the OECD is expected to reach a final agreement on a global minimum tax, which is part of its two-pillar international tax reform project. And unlike many international tax topics, the minimum tax has attracted a lot of mainstream attention. So, I'm really glad that we have you here today to break down the aspects of the proposal and what it means. So, to start, could you please explain for our listeners what the OECD's minimum tax proposal entails?

Mark Strimber: Sure. Yeah. This obviously is a hot topic and a lot of dialogue and debate and discussion around the global minimum tax. As you did mention it as a two-pillar initiative. Pillar 1, which was kind of like a nexus rule that will essentially like replace old permanent establishment rules and provide taxing rights where products are sold or services are provided. Pillar 1 is designed and aimed at very large multinational enterprises. For example, those that might exceed €20 billion or— and its profitability exceeds 10 percent. So, pillar 1 was designed for the very large multinational enterprises.

What is being discussed more in the marketplace is pillar 2. And pillar 2 introduces a global minimum tax rate, which essentially means the minimum like floor within the global tax rate cannot fall. So, like the minimum threshold of a tax rate. And the number thrown out there currently is 15 percent. Pillar 2, the global minimum tax, is to some degree a top-up tax, which essentially has asked all the countries to introduce into their legislation the minimum tax rate of 15 percent. But, should a specific country or jurisdiction choose not to implement that 15 percent tax rate, then the ultimate parent company or some other entity within the structure would be required or would charge the additional tax.

So, say for example, the parent company is at a 20 percent rate, but it operates in a jurisdiction or has a subsidiary that operates at a 10 percent rate, which is five percentage points lower. The top-up tax in that sense would say the ultimate parent has to pay the additional 5 percent, that delta between the 15 and the 10. So, the global minimum tax is designed really to even the playing field in the marketplace. And, in order to give some sort of basic and minimum threshold of the tax to be charged. There are a lot of rules and nuances that have to be worked out based on the OECD's blueprint of the global minimum tax. And as different countries pass their specific legislation in regards to the global minimum tax certainly and hopefully we see consistency in that. But there will be some interesting rules to flesh out.

At a very high level, there are three or four rules that are introduced into the global minimum tax. And not to get too bogged down into the details, but the rule we described is known as the income inclusion rule, which, as we said, operates to require a parent entity to bring into account the lower-tax entities that it may own in order to top-up or equal the 15 percent.

As a backstop to that, they're also proposing to introduce what they call the under-taxed payments rule, which if not able to achieve the 15 percent through the income inclusion rule, there could be an additional tax imposed potentially on payments that take place within the multinational enterprise group. Again, the reason for this is designed to prevent base erosion.

A third rule is the subject to tax rule out there, which is more of a treaty specific rule. And that targets forced jurisdiction, which was introduced originally by the BEPS initiative, the base erosion profit shifting. The treaties based rule targets risks to source jurisdictions where intragroup payments are taking place and are trying to take advantage of low nominal tax rates. In the subject to tax rule, there could potentially be an additional seven and a half to nine percent either withholding tax or some additional tax.

Again, that's imposed on those types of payments, such as interest and royalties. So, there's a whole set of rules and still we have to see how all that gets into legislation. But at a high level, that's what the rule is designed to achieve.

Nana Ama Sarfo: Thank you very much for that overview. I mean, you broke down a really complex set of rules and complex proposal really succinctly. Now, why does the world in the eyes of the OECD and others even need a global minimum tax?

Mark Strimber: Yeah, that's a great question. What we're seeing is this is not really something new. The OECD back in 2013, I think it was, when they — or even before that — when they started the BEPS initiative and looking essentially to target companies that were artificially allocating revenue and profits into low-tax jurisdictions. And this allowed multinational enterprises to shift profits to locations where they may not have employees. They may not have real substance. They may not have boots on the ground, investment in that country, but still they were able through the way the tax rules are designed to allocate a fair amount of profit to that jurisdiction and pay a very low tax rate. This causes a lot of anxiety in the system. You know, countries want to get their fair share of the revenue.

And through all of the BEPS action items, they're all designed essentially to look at this base erosion and profit shifting eroding the tax space in one jurisdiction to a lower-tax jurisdiction and shifting the profits into that jurisdiction. This is a build off of that. And in the countries that companies are taking advantage of the tax system and to a large degree unfairly paying a lot less tax than they should. So, there's a lot of momentum behind this initiative for that reason alone.

There's other reasons that are relevant as to why countries are now looking at the global minimum tax. One of them has to do with the unfortunate pandemic that we've experienced. And there's been a lot of costs in the system that countries are looking to recover. So, COVID-19 recovery through taxation is on the mind of the countries. Countries have said that recognizing what they might view as a single country solution. So the global minimum tax, if established and passed into law in each jurisdiction, means there's more of a consistent set of rules. And one doesn't necessarily have to guess what the taxing rights or the tax law is in each country. Of course there'll be nuances that would be developed. But if everyone plays by the same general rule of a 15 percent minimum tax.

A single country solution is not ideal. We're looking for a multilateral agreement, where all the countries chime in. Single country solutions where one country decides how to tax profits generally is inconsistent, could cause double taxation, both in that local country and in the parent country, for example, on uncertainty, as we had mentioned as well. So, that's important.

Probably one of the most important things of this is the countries are finally, if you will, waking up and saying tax law is very behind the times. And the past view of taxing companies based on physical presence — where do you have assets or where do you have employees — is not the way the economy works anymore. The economy is now a digital economy. And the digitalization of the economy has caused the countries to revisit the entire taxing system and saying, "We need something more consistent, more certain, and certainly something that we'll be able to capture profits wherever they might rise."

Nana Ama Sarfo: That's all extremely interesting. I mean, as you had mentioned, this overall discussion has been going on for quite some years. But, along those lines, can you explain how the discussion specifically about a global minimum tax has progressed over the past few months or even the past year? Because not that long ago, the idea of a global minimum tax seemed preposterous and now it's a reality.

Mark Strimber: Yeah, that's quite interesting about how that certainly developed. You know, it started recently with the G-7 countries, with Canada, France, Germany, Italy, Japan, U.K., and U.S. And they introducing this global minimum tax and trying to build momentum behind it. And starting with that and then moving to the G-20 countries. And ultimately, as it stands, I believe there's 130 countries that have already agreed and signed up.

So, I think there's a lot more at stake these days. As we had mentioned, there's a need for additional revenue within the various countries. Companies for a long time have been allocating profits, as we mentioned, into jurisdictions without substance. And countries finally realizing is that, you know, rules are really required to capture that. So, there's more of a focus on international taxation than there has been in the past. And that's certainly built up momentum around the minimum tax.

I think part of it too, is the U.S. back in 2017 with the Tax Cuts and Jobs Act, TCJA, and introducing their GILTI regime, the global intangible low-tax income regime, essentially requiring U.S. shareholders of foreign corporations to pick up the income of that foreign corporation as U.S. taxable income. And the U.S. being a country where there's a lot of multinational enterprises have their headquarters. I think countries have seen over the last couple of years that this is something that has taken off. Whether it works in the U.S or not is probably a separate debate. But a lot of the global minimum tax rules, for example the income inclusion rule, is built off of GILTI. So, that was one step where the deferral of taxation on offshore profits is not the same as it was in the past and a lot more difficult to achieve. So, all of that together, I think has certainly built momentum around the need and the desire by the countries to generate more revenue and to bring the taxing rights into the country.

Nana Ama Sarfo: So, as you had mentioned, the G-7 and G-20 countries have really built momentum around this idea. But which countries in particular have emerged as power players in this overall negotiation? And what are their concerns?

Mark Strimber: Yeah, the U.S. certainly has a lot of support for the global minimum tax. We've heard the U.K. as well. I think all of them have come out strong. Germany as being a strong player in the marketplace has come out strongly as a advocate for the global minimum tax.

Some of the concerns that the countries have number one is I think would be how will this get passed in their local legislation, right? So, the leaders of the countries have been outspoken about how supportive they are of the global minimum tax. But there's always the nuances that will come up as to how that all gets passed into legislation and what it looks like at the end of the day. I think the fact that we've seen support for it over the last couple of months and a lot of countries signing onto it, I think calms them down a bit. But it doesn't take away from a bit of the anxiety of will they be able to actually pass this into law?

For example, the U.S. being a proponent and outspoken on the topic. We have a lot of domestic laws, of course, and processes that have to be followed for something like this to get passed into law and into our legislation. So, I think that's going to be a challenge for the countries and to see can they do this in a multilateral way? And as a uniform approach?

The other thing that concerns them is will they be able to get support for this from some of the jurisdictions that potentially are opposed to that? So, there are countries like Ireland and Hungary and Estonia in the EU that have said, "No, we're not— we're not on board with the global minimum tax." There are tax haven countries out there that still are not supportive potentially of the global minimum tax. And if countries are still a holdout, and they're not aligned with the proposal, potentially that could negate some of the benefits that the countries see in the global minimum tax.

So, getting the support from countries like an Ireland, where there's a lot of investment into that country, and a lot of revenue comes from the activity that takes place because of their lower tax rate. Getting countries like that on board could be a little bit difficult. And a concern could be is if they're not on board, does that shake up the whole system? And is it really then truly multilateral? And at the same time, will other countries then follow suit and say, "Well, we're not going to adopt." Or just saying, "Well, hey that is proposed because it doesn't work for everybody and we'll start rethinking what it is."

And the other thing is the developing countries that are trying to attract businesses and revenue. They potentially don't want to have a global minimum tax. They're looking for maybe a lower tax rate in order to attract businesses. And that could be a concern as well as to what that means from a global economy place. Possibly if there's a tax anyway, in a higher-tax jurisdiction than a lower-tax jurisdiction, those countries will not necessarily attract the same amount of investment if they're taxed anyway at the higher rate. And people may not go look at the developing countries as an investment. And that certainly prevents some economic growth. So, there's a lot to see about how all these things, I think, interact and the interplay of them and where it all ends up.

Nana Ama Sarfo: So, to summarize, it seems like the devil is not just in the details, but also in the implementation and the likelihood of that implementation within different countries. Now, along those lines, a few different minimum tax rates have been suggested over the past few months. And I would love to hear your thoughts on what the policy justifications might be for a 15 percent rate or a 21 percent rate, or even a 10 percent rate.

Mark Strimber: Yeah. I think what's happened is they've looked for something which would be acceptable and palatable by the countries. And let's start with something that makes sense. And then we can see how we adjust it. You know, there's been reports that the U.S. is looking for an even higher rate, possibly 21 percent. And that actually is part of President Biden's proposal the Made in America tax plan to have the GILTI rate at 21 percent. So, that's an indication that the global minimum tax rate in the U.S.'s mind maybe is at 21 percent. But they've given their support for the 15 percent.

Countries that have operated at 10 percent, or somewhere between 10 and 15 percent, are still viewed as not fully full tax havens, but not really at the rate that that is accepted. So, I think 15 percent in people's minds was more of a compromise as we don't want to go too low because that doesn't achieve our goals. We also don't want to go too high because we probably won't get enough support. So, let's pick something that it fits well enough to adapt, but then at the same time, once we're there, maybe some negotiations we can get higher. And I think they've landed at the 15 percent that way.

Nana Ama Sarfo: So, speaking of this 15 percent rate, what could that mean for particular countries or regions? I mean, who stands to benefit and who could be disadvantaged if the minimum rate is set at 15?

Mark Strimber: I think because the global minimum tax is a top-up tax. Right? So, if lower-tax jurisdictions say we're going to stick at our 10 percent, or even our 2 percent or 0 percent, in that sense, that country might potentially not attract the same investment that they would. There's a lot of discussion out there that the powerhouse markets of the world, as they say, the rich get richer. They're the ones who would really benefit from the minimum tax.

And again, I think that's primarily because the lower-tax jurisdictions have been attractive because of that tax rate. But if there is acceptance for the global minimum tax, even if it's at 15 percent, people might not necessarily want to go invest in a country with a lower tax rate as a developing country, or even if developed, but have some uncertainty as to how do they get to that lower rate versus if there's an accepted 15 percent rate.

Plus on top of that, if I don't pay my 15 percent in the local country, I may have then pay that additional delta between the lower rate and the 15 rate in my headquarter country. Doesn't really make sense to make that investment in that low-tax jurisdiction when I'm not perhaps ultimately saving tax. Now, there are exceptions that would be discussed as well. But that probably is where the benefit is and the countries that are supportive of it, who house a lot of the headquarter and the parent companies for these multinational enterprises, it seems like they're the ones who stand to benefit versus the tax havens in the lower-tax jurisdictions, including the developing economies.

Nana Ama Sarfo: Ah, I see. That's very interesting. Now, to round out our discussion, as you very well know, the minimum tax is supposed to prevent the so-called race to the bottom on corporate taxation. That being said, the OECD has been discussing some carveouts and exemptions for this minimum tax. So, based on what has been publicly discussed, are there any ways in which those proposals could potentially diminish the effectiveness of a global minimum regime?

Mark Strimber: Yeah, for sure. As in every low-tax legislation, there's going to be exceptions to that that could be proposed. And so, for example, in this situation, in the global minimum tax, there's a substance-based exception that's been proposed. Which essentially would allow for an exemption of profits from the global minimum tax if those are perhaps reinvested into appreciable assets, or they're used for payroll costs within the local country. Substance being the key word there. If there's enough substance that one has in the jurisdiction, perhaps having some benefit of that substance would lower the effective rate. And again, actually that is built off of the global intangible low-tax income exception, where if you have a certain amount of investment of depreciable property that reduces the amount of GILTI that the U.S. shareholder has to pick up. So, they've discussed an exception possibly for substance-based exception, as we said, focused on investment in that specific country or payroll, I think it was about a seven percent, seven and a half percent, return that was being discussed with respect to that.

The other thing that potentially could perhaps diminish the effectiveness is things like state aid or deductions, if you will, that could be introduced. So, a country could potentially say, "OK, I have a 15 percent minimum tax, but I can provide some other benefits to a company that wants to invest in my country." Or applied deductions and things like that, depending on how the rules are all laid out and how they shake out. But maybe deductions or credits that could potentially reduce the effectiveness because, OK, maybe while the effective tax rate is 15 percent, but I'm giving you some sort of return for your investment you make here, or some credits, or tax credits, or could be research and development or whatever the case may be. So, the more exceptions and loopholes, so to say, that are introduced, could certainly diminish the effectiveness of the global minimum tax.

What's interesting about the global minimum tax, which I don't think I mentioned at the onset of our discussion, is that it isn't targeted specifically at any industry. For example, we have the digital service tax that we're familiar with that has been enacted in various countries. You know, that is designed to target companies potentially in technology space. But the global minimum tax would apply across the board. So, possibly countries could focus on different industries that they may have attracted in the past. And potentially, again, provide some sort of benefit or deduction to attract or continue to attract those investments, which would reduce the effectiveness of the tax. So, as you said, devil's in the details, but also in implementation and how could it be enforced.

Enforcement is going to be quite a challenge. How does this all get reported, right? And is it something like the country-by-country reporting where you have to fill out all of your company's activities and there's information sharing that would take place? That's something I think to see, yet to come. If there is dispute and how that gets worked out and how supportive are the countries of disputes that take place will be important in order to really make this effective. Nobody wants to see unfair taxation or double taxation, and that's going to be important as well. So, while the blueprint laid out from the OECD laid out a lot of their thoughts and thinking, it also mentioned things that they felt needed follow-up. And I think over the next month or two and into 2022, as they're looking to get this passed and into legislation, we'll see how all the rules shake out and where everything ends up.

Nana Ama Sarfo: Well, Mark, I have to thank you so much for that very clear and insightful overview. I think it will be definitely interesting to see how all of these details are negotiated over the next few weeks and months. And even beyond that. It's certainly fascinating to see a tax history unfold in front of us in real time. So, again, thank you so much for your time and for joining us on the podcast.

Mark Strimber: Thank you, Nana. Yeah, it certainly is a great time to be involved in taxation and especially international taxation. I appreciate you having me, and thank you.

David D. Stewart: And now, coming attractions. Each week we highlight new and interesting commentary in our magazines. Joining me now is Acquisitions and Engagement Editor in Chief Paige Jones. Paige, what will you have for us?

Paige Jones: Thanks Dave. In Tax Notes Federal, Herbert Beller considers different scenarios and interactions involving S corporations and their affiliated entities. Craig White explores three factors that affect defined contribution plan retirement goals. In Tax Notes State, Jeffrey Friedman and Alla Raykin examine Murphy v. NCAA and the anti-commandeering doctrine. Tom Yamachika discusses how businesses operating in Hawaii through an affiliate should account for the state’s general excise tax on intercompany transactions. In Tax Notes International, three tax professionals at the Vienna University of Economics and Business comment on their project, "Cooperative Compliance: Towards Improved Tax Certainty.” Matthew Frank examines whether there are any meaningful limits on the IRS’s choice of how to frame a transfer pricing inquiry. In featured analysis, Nana Ama Sarfo interviews Jiyeon Lee-Lim, the global chair of Latham & Watkins’s tax department, about her philosophies on becoming a partner and leader in tax. On the Opinions page, the top commentary editors share topics they hope to see covered this fall in the latest editors' wish list. Joseph Thorndike highlights how transformative the Economic Recovery Tax Act of 1981 has been in tax policy and politics.

David D. Stewart: That's it for this week. You can follow me online @TaxStew, that's S-T-E-W. And be sure to follow @TaxNotes for all things tax. If you have any comments, questions, or suggestions for a future episode, you can email us at podcast@taxanalysts.org. And as always, if you like what we're doing here, please leave a rating or review wherever you download this podcast. We'll be back next week with another episode of Tax Notes Talk.

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